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Shadow banks surge amid APRA crackdown

The burgeoning shadow finance sector is shaping up as the next battleground for regulators, whose crackdown on banks threatens to spur a surge in potentially risky lending by non-banks to apartment buyers and developers.

While still in its infancy, the unregulated industry is experiencing a surge in growth that is expected to continue as the squeeze on regulated banks intensifies.

"The APRA lever has dramatically altered the marketplace and limited funding to borrowers," said executive chairman of Australia's largest commercial loan manager Balmain Capital Michael Holm.

While non-bank lenders account for about 6 per cent of the financial system, the Reserve Bank of Australia signalled earlier this month that it has the sector in view, after announcing a raft of restraints such as limits on interest-only loans to curb the flow of credit to investors that have been blamed for inflaming the nation's property market.

"The tighter post-crisis prudential framework for the regular banking system creates a risk that credit provision will migrate to the less regulated shadow banking sector," RBA officials say in the latest financial stability review.

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The central bank also noted that securitisation warranted "ongoing attention" and new figures show non banks have issued $5 billion in residential mortgage-backed securities so far this year.

Former RBA governor Glenn Stevens, who finished his term last year, repeatedly warned while in office that one of the consequences of the introduction of so-called macroprudential tools could result in parts of the finance industry setting up shop outside supervisory ring-fences.

Quest for yield

The new wave of lenders operate by intermediating between large pools of local and foreign capital desperate for yield in a world of ultra-low official interest rates with property developers or buyers who have been unable to get loans from regulated banks.

Providers of capital to the non-bank lenders have been lured by returns of as much as 33 per cent for very short term loans, compared to the official cash rate of just 1.5 per cent, although the standard rates vary between 7 per cent for apartment loans to 20 per cent for development loans.

Sydney-based private lender Development Finance Partners said there was definitely unmet demand.

"Private lenders cannot keep up with the demand from foreign buyer purchases seeking finance to settle their purchase contracts," director Matthew Royal said.

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"There is a large pool of customers with very limited competition for private lenders lending to foreign buyer purchasers.

"We have capital lines available, however, we are constantly looking for additional capital sources to help meet unmet demand especially with respect to low doc facilities where the opportunity is the greatest," Mr Royal said.

ASX-listed mortgage broker N1 Holdings, a popular go-to broker for foreign buyers, has been referring on calls for funds.

"We are very busy. Every day we get inquiries, inquiries from people who need to settle and developers who can't borrow from banks," chief executive Ren Hor Wong said.

Experts say the sector doesn't yet pose a systemic threat to the economy, as any potential losses would be borne by a relatively small pool of lenders. However, because there is relatively little direct oversight, concerns are growing that problems could emerge that cause wider damage to the economy.

The Australian Prudential Regulation Authority has no direct responsibility for the sector, and the Australian Securities and Investments Commission only supervises mortgage lenders as part of its mandate to uphold the National Consumer Credit Act. This doesn't cover commercial development or construction finance lenders.

Gresham Property's Mike Burley and Ami Simon recently started another new development fund. Julian Andrews

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An ASIC spokeswoman said the regulator was working with the Australian Small Business and Family Enterprise Ombudsman to ensure lenders providing business loans of up to $1 million "understand their obligations under the ASIC Act".

APRA changes 'dramatically altered' the market

Balmain's Mr Holm said the macroprudential crackdown had dramatically spurred activity in the sector. "The space is opened by the withdrawal of the banks and is being slowly closed by private markets."

DFP's Mr Royal said APRA's actions had pushed a lot of borrowers into the non-bank sector. "A lot of borrowers are pushed out. They have got to go somewhere and refinance in another market."

A spokeswoman for ASX-listed private mortgage lender Pepper said: "The non-conforming lending market was increasing in size, mainly as a result of the growing population of borrowers and tightening of credit criteria by traditional bank and other prime lenders."

Attendees at this Sydney expo last week were told they could invest in residential loans that were returning between 6 and 15 per cent. Christopher Pearce

Industry sources said demand was strong for two kinds of residential loans – mortgages to both foreign and local homebuyers who have been turned away by banks, and development and construction loans to residential developers who are overseas-based and do not have enough experience, or lower-tier developers unable to sell enough apartments prior to securing funding from a bank to start construction.

Funds are being sourced from high net worth investors, foreign banks, local superannuation funds and foreign pensions funds, which has created a new pathway away from the traditional bank warehousing or securitisation by firms such as Pepper and Firstmac.

Director Tiger Liu said they were sophisticated investors with global portfolios of assets.

"Banks' reduced lending has led to an explosion of private lenders. The thing is, as long as the projects are in right location, with risks managed and at lower loan-to-value ratios, returns can be lucrative."

Also in residential projects, superannuation funds Local Government Super and Fire & Emergency Services Superannuation Fund have tapped into the residential lending business through fund manager Centaur Property's real estate debt funds.

Gresham Property, Chifley Securities and Qualitas have rounded up funding from institutional investors, private equity, hedge and superannuation funds. Zank & Co, Chifley Securities, Mortgage Ezy and La Trobe Financial have also joined the stalwarts of the industry such as Pepper and Firstmac.

'People need a bit of non-conforming lending'

For commercial residential loans, depending on the type, length and loan-to-value ratio of the loans as well as the quality of the assets, private lenders are charging double digit rates around 12 to 20 per cent and there have been cases where 33 per cent was charged for very short-term loans.

Mortgage and home loans are cheaper. Pepper and Firstmac's home loan interest rates are around 5 to 6 per cent. DFP and Mortgage Ezy rates reach 8 per cent, but these higher rates apply to foreign buyers, to whom major banks have turned off lending. Pepper and Firstmac lend only to local owner occupiers and some investors.

These rates are much higher than compressed direct residential and commercial property gross returns at around 3 to 5 per cent in metro areas.

Whether regulation was needed, Mr Holm said the small size of the sector was unlikely to grow fast enough to fill the gap left by the major banks, responsible for about 95 per cent of loans in Australia.

"All the non-bank players recognise the opportunities, but it's a big bucket to fill," he said.

Private lending is mostly consumed by developers rather than investors because they can afford the high rates which private lenders are seeking. This in turn has the effect of improving supply, which would cool houses prices, former Babcock & Brown executive and Alceon managing director Trevor Loewensohn said.

The end buyers, who control price movements, have a more elastic demand to higher interest rate products.

"I don't know what that tipping point is, but at some point, people will say "that's too much". But you also got to distinguish between local and foreign investors. For foreign investors, it's more of a long term view...local investors will tap out at a certain level," Mr Loewensohn said.

Chinese-backed Realty Base Group's Ted He who is planning an "apartment fund" suggests that level to be 10 per cent interest rate - the amount of deposit buyers would have to abandon if they walked away from an apartment purchase.

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Chifley Securities' Dominic Lambrinos agreed, saying the non-bank loans, even at a higher level now, paled in comparison to the volume generated by the major banks.

"Chifley will arrange for more than $1.5 billion in [commercial] loans this calendar year. Even with this large activity, one of the major four banks can equal that amount of loans in 1 to 2 days; and that's just 1 of the 4 big banks and none of the second tier banks," he said.

And banks need the "looser" private lending sector to provide a buffer, even if APRA wants to cool the residential market and tighten up lending policies, Mr Royal said.

While Mr Cannon was concerned some of these players, who were taking advantage of current market opportunities, might end up defeating the cooling APRA wanted, property financier Wingate's Ryan Levin did not believe the current size and scale of non-bank lending would "weaken APRA's aims".

"I think APRA is going to succeed in its efforts. This is the first time we have seen APRA pull that third lever, the regulatory lever, and it's going to be very interesting," Mr Holm said.